Money market funds are mutual funds that hold short-term debt, not deposit accounts at a bank

A money market fund is a type of mutual fund — a pool of money managed by an investment company — that buys very short-term debt like Treasury bills, commercial paper, and certificates of deposit. You own shares of the fund, not the debt itself. The fund's value stays close to $1 per share, which is why it feels like a savings account, but it is not one. You are investing in securities, not depositing money into a bank.

This matters because money market funds are not insured by the Federal Deposit Insurance Corporation (FDIC). If the fund loses money, you lose money. A money market account at a bank — which you may have seen while shopping for savings options — is different: it is a deposit account, FDIC-insured up to $250,000, and the bank pays you interest. Money market funds are sold through brokerages and investment firms, not banks, and they work like any other mutual fund investment.

The reason people confuse them is the name. Both hold money and both aim to be safe, but one is a bank product and one is an investment product. Understanding which one you are looking at matters before you move money into it.

Key Takeaways

  • Money market funds are mutual funds that invest in short-term debt securities, not bank deposit accounts, so they carry investment risk and no FDIC insurance.
  • You buy and sell shares of a money market fund through a brokerage or investment account, not through a bank.
  • The fund aims to keep its share price at $1, but the value can drop if the underlying securities lose value.
  • Money market funds typically pay higher yields than money market accounts during periods of rising interest rates, but the rate can fall when rates drop.

What money market funds actually hold

A money market fund buys debt that matures in less than one year — usually much less. The fund manager purchases Treasury bills (short-term government debt), commercial paper (short-term corporate debt), and certificates of deposit from banks. These are all considered very safe because they mature quickly and are backed by stable borrowers.

The fund holds a mix of these securities so that some are maturing almost every day. When one matures, the fund gets its money back and buys another short-term security. This constant turnover is why the fund's value stays stable — it is not betting on long-term price movements the way a stock fund does.

Because the underlying securities are so safe and short-term, money market funds have historically been one of the lowest-risk mutual fund types. But "low-risk" is not the same as "no risk." If the borrowers (the government, a corporation, or a bank) fail to repay, the fund loses money and your share value drops below $1.

How the interest rate you earn works

A money market fund pays you a yield — a percentage return on your investment — based on the interest rates the fund earns on the securities it holds. If the fund buys Treasury bills paying 5 percent, and commercial paper paying 4.5 percent, the fund's overall yield will be somewhere in between, minus the fund's operating expenses.

The yield changes constantly because the fund is always buying new securities at current market rates. When the Federal Reserve raises interest rates, new securities pay more, so the fund's yield rises. When the Fed cuts rates, new securities pay less, so the fund's yield falls. You do not lock in a rate the way you do with a certificate of deposit — your yield moves with the market.

The fund distributes this interest to you daily or monthly, depending on the fund. Some funds automatically reinvest the distributions (buying more shares), and some pay them out to your account. Check your fund's prospectus to see which one you own.

The difference between money market funds and money market accounts

A money market account is a bank deposit account that works like a hybrid between a checking account and a savings account. It is FDIC-insured, the bank pays you interest, and you can usually write checks or use a debit card. The bank sets the interest rate and can change it whenever it wants.

A money market fund is an investment you buy through a brokerage. It is not FDIC-insured. The yield depends on what the fund earns on its securities, which changes with market interest rates. You cannot write checks on most money market funds (though some allow limited check-writing), and you buy and sell shares like you would with any mutual fund.

During periods when interest rates are high and stable, money market funds often pay more than money market accounts because they are buying securities at high rates. But when rates fall, money market fund yields fall faster than bank rates sometimes do, because the fund is constantly buying new securities at lower rates. A money market account's rate may stay higher for a while because the bank is slower to cut it.

Costs and fees you will encounter

Money market funds charge an expense ratio — an annual fee expressed as a percentage of your investment. This fee covers the fund manager's salary, the cost of buying and selling securities, and administrative costs. Expense ratios for money market funds typically range from 0.1 percent to 0.5 percent per year, though some are lower and some are higher.

If you own a money market fund with a 0.2 percent expense ratio and the fund earns 5 percent, you receive about 4.8 percent after the fee. The fee is deducted automatically — you do not write a check for it.

Some brokerages also charge transaction fees when you buy or sell fund shares, though many large brokerages have eliminated these fees. Check your brokerage's fee schedule before you invest. Some money market funds are "no-load," meaning no sales commission, while others charge a load (a percentage of your investment) when you buy. Always read the fund's prospectus to see what you are paying.

When money market funds make sense and when they do not

Money market funds work well if you have money you do not need for a few months and you want a yield higher than a savings account, and you are comfortable with the small risk that the fund's value could drop. They also work well as a temporary holding place for cash in an investment account while you decide what to do with it.

Money market funds do not make sense if you need the money within weeks, because you might have to sell shares when the fund's value is temporarily down. They also do not make sense if you want FDIC insurance — a money market account or high-yield savings account at a bank is the right choice for that. And they do not make sense if you cannot tolerate any risk of losing principal, because even though the risk is small, it exists.

If you are comparing a money market fund to a high-yield savings account at a bank, look at the current yield on each, subtract the money market fund's expense ratio, and compare what you would actually earn. In many cases, a high-yield savings account is simpler and pays just as much.

How to buy a money market fund

You buy a money market fund through a brokerage account — an investment account you open with a company like Fidelity, Vanguard, Charles Schwab, or your bank's investment division. You will need to provide identification and basic financial information to open the account.

Once the account is open, you can search for money market funds by name or ticker symbol. Most brokerages let you filter by expense ratio, yield, and fund company. You choose how much to invest, and the brokerage buys the shares for you. The money comes from your linked bank account or from cash already in your brokerage account.

You can sell your shares anytime the market is open, and the money goes back into your brokerage account. From there, you can transfer it to your bank account. The whole process usually takes one to three business days.

Frequently Asked Questions

Can I lose money in a money market fund?

Yes, though it is rare. If the securities the fund holds lose value or default, the fund's share price can drop below $1. This happened during the 2008 financial crisis when one major money market fund "broke the buck" (fell below $1). The risk is small for funds holding Treasury bills and high-quality commercial paper, but it exists.

Is a money market fund the same as a money market account?

No. A money market account is a bank deposit account with FDIC insurance. A money market fund is a mutual fund investment with no FDIC insurance. They have similar names but work very differently.

What happens to my money market fund yield when interest rates drop?

Your yield falls because the fund is constantly buying new securities at lower rates. If rates drop from 5 percent to 3 percent, the fund's new purchases will pay 3 percent, so your overall yield will decline over weeks or months as old securities mature and are replaced.

Can I write checks on a money market fund?

Most money market funds do not allow check-writing. Some funds offer limited check-writing privileges, but you have to check the fund's prospectus. If you need check-writing, a money market account at a bank is a better choice.

How often does a money market fund's value change?

The share price is calculated daily after the market closes. Because the fund holds very short-term securities, the price usually stays at or very close to $1. Large price swings are rare but possible if the underlying securities lose significant value.